Industry Trends
Navigating the global private equity 2024 landscape
It discussed the challenges and changes in the private equity industry over the last 24 months. Despite concerns about a potential recession, the economy has remained stable with record-low unemployment, reasonable growth, and surging public markets in the US. However, these conditions have put pressure on General Partners (GPs) to find liquidity solutions and devise new ways to generate profits. It suggests that the industry needs to focus more on generating strong, profitable, organic growth rather than relying on multiple expansion and revenue growth. It also discusses the need for funds to appraise their portfolio companies and consider innovative solutions like continuation funds, securitizations, and NAV financing. It highlights the importance of professionalizing fund-raising and communicating effectively with Limited Partners (LPs). Despite a 20% drop in overall deal count and a 24% fall in exit transactions in 2023, the industry has demonstrated resilience. It concludes by noting the enduring appeal of private equity for LPs due to its steady long-term returns and diversification. At a glance, private equity continued to reel in 2023 as rapidly rising interest rates led to sharp declines in dealmaking, exits, and fund-raising. The exit conundrum has emerged as the most pressing problem, as LPs starved for distributions pull back new allocations from all but the largest, most reliable funds. The long-term outlook remains sound, but breaking the logjam will require more robust approaches to value creation and rapid innovation in liquidity solutions.
Source: Bain & Company
2024 Analysis: Decoding private equity in Asia-Pacific
In 2023, deal value in the Asia-Pacific region fell to $147 billion, a 35% decrease from the previous five-year average and a 59% drop from the 2021 high of $359 billion. This extended the dealmaking slump that began in 2022. The average deal in 2023 was 7% smaller than the prior five-year average, and there were fewer megadeals. However, the average megadeal was 30% larger than the previous five-year average. The technology sector, which represented the largest share of deals in the region, saw its share fall to 27% from the prior five-year average of 41%. The energy and natural resources sector was the only one to record an increase in deal value and deal count. Global fundraising declined by 17%, with Asia-Pacific-focused funds falling to 9%. These funds raised $100 billion, a 26% fall from 2022 and a 60% drop from the prior five-year average of $248 billion. Despite the fundraising difficulties, the estimated level of dry powder, or total unspent private equity capital, remained consistently high.
Source: Bain & Company
Europe’s growth equity landscape
Growth equity, referring to investments in fast-growing companies with revenue growth of 20% per year or more, is a compelling segment for private equity (PE) firms and institutional investors in Europe. The market is fragmented with about 1,500 transactions per year and concentrated among investment firms. Over the past five years, investors have raised over $100 billion to invest in European companies in the growth equity stage. The number of growth equity deals in Europe grew from 1,200 to nearly 1,600 between 2018 and the first half of 2021. However, deal volume has contracted significantly since the second half of 2022 due to high interest rates and reduced investor appetite. The market is highly fragmented and concentrated, with the top ten fund managers accounting for 45% of raised capital. Strategies for investors include looking at companies that will soon grow beyond the venture stage, focusing on mature verticals with strong growth equity investment, and considering less mature sectors with a large volume of VC deals but limited growth equity funding. The most promising sectors include biopharma, analytics, financial technology, payment providers, sustainability technology companies, e-commerce software and technology, marketing technology, and customer relationship management.
Source: BCG
Market Sentiments
The evolution of venture capital in 2024
There is a changing landscape of venture investment and dealmaking, particularly in the wake of a challenging year for private capital. The total venture investment in the third quarter of 2023 was $73 billion, a significant drop from previous years. However, the promise of interest rate cuts in 2024 is offering a glimmer of hope for startups and investors. The three ways that the dealmaking landscape is likely to evolve in 2024 are:
- VCs will proceed with cautious optimism: There is a shift towards more deals in Series B+ stages, and the dominance of AI as an area of investment is set to continue. However, investors are spending more time than ever researching deals, acting with caution after a tough year.
- Relationships and brand trust are critical to doing deals and fundraising: The focus has shifted from deal sourcing to expanding networks and strengthening existing relationships. Most VC and PE investors are centralizing all the real-time network data that sustains relationships across their entire firm.
- AI combats deal complexity and competition: Firms are planning to adopt more AI across their workflows in 2024 to drive productivity, accelerate researching companies of potential interest, and decide whether or not to invest in a company. AI can help streamline the deal research process and allow investors to reach data-backed decisions faster.
Source: Forbes
Direct lending outlook: High return potential, more deal activity
In our view, 2024 could extend the trend of rewarding years for investors in direct lending strategies. While higher-for-longer interest rates, slower growth and stickier inflation may present challenges for some borrowers, It is not expected that credit losses to become unhinged. Instead, the benefits investors are seeing from higher rates will outweigh pockets of concern in portfolios and create attractive new opportunities for selective lenders. High interest rates in 2023 cooled deal activity, which had hit record levels in 2021 and 2022. Despite the lower volume, returns for investors in direct lending peaked last year, as the benefit of higher rates and the recoupment of mark-to-market markdowns taken in 2022 more than offset a modest uptick in losses. Here’s a closer look at what the investors can expect this year:
- A (Moderate) Decline in Asset Yields, but Above-Average Return Potential
- Emphasis on Asset Selection, Portfolio Construction
- More Robust Deal Activity
- A Bigger Opportunity Set
Even with yields likely to moderate from their 2023 peak, the returns will exceed those seen in prior years. Of course, some borrowers are likely to struggle with higher rates, so the key for investors will be finding a manager well-positioned to minimize losses. It is believed that direct lenders who maintain discipline and stay selective will be best suited to deliver strong risk-adjusted returns.
Source: AllianceBernstein
Restructuring wave coming for private equity
In 2023, a record number of private equity owned companies filed for bankruptcy due to heavy debt loads and rising interest rates. Among the 642 total bankruptcy filings, 104 were of PE-backed and venture capital-backed companies, marking a 174% increase compared to 2022. Medical apparel provider Careismatic Brands, a portfolio company of Swiss PE firm Partners Group, filed for Chapter 11 to eliminate $833 million of its debt and reduce its interest rate burden. The company's interest expenses rose to $64 million in 2023, a 179% increase compared to 2019. Seth Friedman, managing director at Abacus Finance, noted that fixed charge coverage ratio covenants have become important again in loan covenant packages. He also mentioned that PE firms are prepaying debt to reduce the burden on their portfolio companies. René Canezin, a managing partner at Evolution Credit Partners, stated that lenders consider three scenarios in a stressed environment: the company's need for time to adjust to a rate increase, whether the business model is broken, and whether the rate increase revealed that the business model won't work in a normal rate environment. He also mentioned that most companies are able to amend and do soft restructurings.
Source: The Middle Market
The disintermediation of lending - Private debt shines bright
In the realm of alternative assets, private debt has emerged as shining star, experiencing a rapid evolution and now basking in what many are calling a golden moment. Amid rising interest rates, private debt has remained remarkably resilient, delivering robust returns, and attracting fervent investor interest.
- Disintermediation of lending: Recent events and stress in the banking sector have accelerated the shift of lending from banks to private players, with institutional investor stepping in to fill the void.
- Growth of private debt: Private debt, particularly to companies backed by private equity, is rapidly expanding and forecasted to reach USD 2 trillion by 2027, competing with traditional funding routes.
- Regulatory implications: Tighter regulations on banks may further drive the growth of private debt markets, with regulators preferring institutional investors as lenders.
- Opportunities in commercial real estate: Reduced lending by regional banks presents opportunities for private debt providers to enter the commercial real estate sector, albeit with challenges such as covering financial costs.
- Challenges and caution: The rapid growth of the private debt market brings challenges like unorthodox underwriting techniques and increased leverage, emphasizing the importance of disciplined underwriting and seniority in the capital structure.
- Regional nuance: While the US leads in the private debt market, Europe and Asia also show promise, albeit with regional differences in banking focus and regulatory frameworks.
The disintermediation of lending from banks to private players represents a significant shift in the financial landscape. Private debt presents a wealth of opportunities for investors and borrowers alike. However, navigating this complex and rapidly evolving market requires careful attention to regulatory changes, disciplined underwriting practices, and a nuanced understanding of regional dynamics. By staying informed and adapting to market trends, investors can capitalize on the potential of private debt as a valuable asset class in 2024 and beyond.
Source: UBS Asset Management
Market Opportunity/Challenges
Infrastructure debt – An attractive component in private credit portfolios
Infrastructure debt is an advantageous component of private credit portfolios. It is believed that infrastructure debt can enhance private credit portfolios by providing improved diversification with an illiquidity premium compared to public assets, attractive risk-adjusted returns and downside protection, while benefitting from infrastructure-specific characteristics. There are four fundamental characteristics of private infrastructure debt, which make the asset, class an attractive component of a private credit portfolio: 1. Low Correlation to Corporate Credit, 2. Consistent Performance Across Economic Environments, 3. Compelling Risk-Adjusted Returns, 4. Lower Risk than Equivalent Corporate Debt. Furthermore, it is believed assessing the potential benefits of infrastructure debt is warranted, given the long-term, durable market tailwinds of the asset class:
- Digitalization, increased mobility and decarbonization trends are driving increased demand for infrastructure. There will be increased regulation, social evolution and technological advancements underpinning these trends now and in the future.
- Constrained public investment and bank retrenchment have led to a recent supply and demand imbalance for infrastructure equity and debt, creating opportunities for private markets to fill in the gap.
- The increase in infrastructure equity projects and required financing has resulted in greater need for debt capital providers, as returns for infrastructure equity investors are largely predicated on the amount of financing they can raise.
Global infrastructure investment is expected to exceed $3.7 trillion a year through 20351, with a total gap of $5.5 trillion over the same period that is expected to be funded by private investors, whether via debt or equity. As private lenders have become increasingly critical as a source of capital for infrastructure development, it is believed that the market will continue to provide attractive opportunities for scaled, and experienced infrastructure lenders.
Source: Ares Management
Artificial Intelligence Scope/ Trends
Harnessing generative AI in private equity
Generative AI technologies are causing significant disruption across industries and business functions, including private capital. Firms are leveraging AI to gain insights into potential impacts and opportunities across their portfolios, streamline or automate back-office functions, and enhance the underwriting process. For instance, CVC applied a generative AI lens to over 120 of its portfolio companies to prioritize investment. Italian online educator Multiversity Group used generative AI to answer routine student queries, saving professors' time. Generative AI can also bolster due diligence by providing a more comprehensive picture of a target company’s prospects. Tools can analyse large amounts of customer reviews and convert unstructured text data into structured formats, enabling deal teams to focus on generating insights. Generative AI can also transform fund operations by speeding up the sourcing and evaluation of deals. It can reduce the screening time per company from a day to an hour, making team members more productive. AI tools can also scrape and analyse vast amounts of data, generating clear, analytical reports. Firms are advised to scan their portfolios, link AI initiatives to strategic objectives, manage change effectively, build fluency in generative AI tools, and consider how AI can transform their operations.
Source: Bain & Company
Expert Opinion
Private Equity’s next big leap
AI is potentially a game-changer for PE firms seeking advantage in an ocean of data. If widely and responsibly deployed. It can help unlock incredible value previously unobtainable. The rise of Generative Artificial Intelligence (genAI) has made AI a priority for private equity (PE) firms. GenAI can create opportunities for PE firms, making their deal-making process more effective and improving the performance of their assets. However, harnessing genAI requires technical capabilities that many funds and portfolio companies lack. AI can make humans more productive and accelerate human creativity. There are three major opportunities for PE firms to create value with genAI: improving the speed and quality of the deal process, applying genAI post-close during integration and across all portfolio companies, and freeing up a third of all knowledge worker hours. However, only 24% of PE firms are using AI effectively. To unlock the full value of AI, high-quality, contextual, indexed, and searchable data is needed.
Here are five actions Per and Chris recommend that PE firms can take now to keep up the pace:
- Unleash the power of your people: Start with a bottom-up approach, make AI tools available for everyone to find their own ways to cut hours from their work. This could prove very effective in freeing up to 40% of people’s time — even without proprietary data and training.
- Pilot high-value use-cases: Launch pilots to demonstrate the power of combining AI models with your proprietary data to build tailored high-value applications for both the fund and select portfolio companies. The aim is to generate a ‘flywheel effect’ where humans and machines collaborate and amplify each other’s performance and learning. For example, analyse the tasks most knowledge workers spend time on, then pick a subset of these where AI can have an impact. Then build these applications instead of selecting use cases that aren’t well suited for AI development or offer lower value to fewer people.
- Shape your workforce transformation: Most of the near-term value generated by AI will come from augmenting the existing workforce to free up time from a subset of their tasks. To scale broadly will require a carefully designed workforce transformation, with a tailored approach by key roles and focus on behavioral change. A first crucial step is to carry out a value assessment, based on census data and impact benchmarks by industry, function and role. This aims to size the magnitude of the value at stake, where in the organization this resides, reinforced by actual data from the first two efforts to inform the business case for the investment.
- Accelerate data modernization: Data is the essential fuel for the highest value AI applications. In a world where speed can make or break a deal, AI is redefining what’s possible, but data access and governance underpin that goal. Not only do you need to have the data, but it also needs to be in the right place, making data cloud capabilities vital for all PE firms. In many cases, cloud efforts were started before AI but must now be accelerated and funded to meet shorter timelines and higher expectations.
- Launch 'Trusted AI' governance: Given the scale of disruption that AI is likely to create, almost every PE firm will need to take action to minimize risks of widespread adoption. This includes adopting a ‘Trusted AI’ governance framework, ensuring compliance with emerging regulations and upgrading cyber-protection.
Source: KPMG
'Wealthtech' and changing regulation present opportunities for PE firms in 2024
Christian Kent, a Managing Director at global investment bank Houlihan Lokey, believes that private equity firms can capitalise on opportunities for modernisation, digitalisation, and consolidation in the wealth management sector. The Financial Conduct Authority's consumer duty regulation has put pressure on the approximately 5,000 independent financial advisors (IFAs) in the UK to manage their compliance. As a result, many smaller firms are seeking to join larger organisations to better manage compliance and focus on client services. Kent notes that compliance is a differentiator and well-invested platforms can hire the best people. He also observes that larger firms are getting more enquiries from smaller IFAs due to consumer duty. The UK wealth management sector is growing due to an ageing population and pension reforms. Kent also highlights that the sector is ripe for digitalisation, with wealth management technology companies becoming prime targets for private equity deal activity. He cites FNZ and InvestCloud as examples of larger private equity-backed businesses that have capitalised on wealthtech. Kent believes there is room for consolidation in the UK market, with a trend of private equity-backed platforms moving up the size spectrum.
Source: Private Equity Wire
